What A Cute Fraud – Scamming Apple To Replace Chinese iPhone Fakes

This isn’t perhaps the world’s most sophisticated fraud – we don’t ever hear about them because they’re good enough that they don’t get caught – but it is a cute one, scamming Apple into replacing entirely fake Chinese iPhones. The basic plan is that people in China send over to the US something knocked up in some shed in Shenzen – well, that’s how real iPhones are made after all – and these are then bled into Apple’s replacement system for faulty iPhones. Usually – or often enough – to be replaced with a genuine iPhone that can then be sent back to China for sale:

Two Oregon college students allegedly managed to scam Apple out of nearly $900,000 through a scheme involving counterfeit iPhones, according to the federal government. The scam revolved around counterfeit Apple iPhones that were shipped to students Quan Jiang and Yangyang Zhou from “an associate” in China, the government claims. Jiang and Zhou would allegedly submit the fake iPhones to Apple for repair under the company’s warranty program and Apple, in many cases, would send them authentic iPhones as replacements. In total, the pair submitted thousands of warranty claims for counterfeit iPhones through the end of 2017, according to complaints filed by the federal government in March 2018 and March 2019.

This all depends upon the economics of trying to repair phones – and of trying to prevent exactly such fraud.

Court documents outline a scenario in which the two men imported thousands of counterfeit iPhones from China then filed warranty complaints with Apple, claiming the smartphones were broken and wouldn’t turn on. Apple would then replace the knock-offs with genuine models — in most cases, brand new phones — that the pair would ship those items back to China to be resold for a profit, of which they received a cut.

There are two costs here to Apple. One is just the cost of repairing something. As is common with modern electronics repair is more expensive than replacement. So, something comes in and doesn’t work it’s cheaper to replace it. Well, shrug, some portion of what is made isn’t going to work as advertised whatever we do. The optimal profit level is to be looking at the marginal costs of replace and repair as against those marginal costs of trying to ensure zero defect.

Anyone who has ever worked in any area actually requiring zero defect – say, as I have done, processing chips for space rocket launches – will tell you that accepting 1%, or 0.1% or whatever, replacement rates is much, much, cheaper than trying to ensure zero defect production.

So, shrug, Apple has to give out a few free phones to replace those that don’t work.

Then there’s the other cost. Actually prosecuting a fraud takes time and money too. So, even a known fraud is allowed through often enough. Heck, some kid scamming us for what costs us $300? Get a life and on to the next phone we need to look at. But that policy in itself has a cost, word soon gets out so the fraud rate rises.

A buddy found himself working in medical insurance in the US. Trying to track down, identify and then prosecute possible frauds. The basic rule of thumb was that anything below a certain amount, say, $5,000, back when $5k was real money, was just let through. It’ll cost us more than that just to find out whether the guy even really went to the hospital let alone check deeper. And yet some percentage – from memory, some single digit percentage – was pursued to the bitter ends of the Earth. Even if it looked pretty cool and secure as a claim it was still gone through and checked to every jot and tittle. Including trying to initiate fraud prosecutions against anyone overclaiming even for a Band Aid. That was the way to keep the system as a whole price conscious and also effective. Ignore the small scams in general but check some tiny number of them in great, great, detail. Just to keep the costs of scams to the system down by putting the fear of God into the small time scammer.

As with Apple and the iPhone scams. The way to keep these costs under control is to just pay up for all small scale claims without checking anything very much. But also making sure to catch a few scammers through detailed and rigorous investigation and make sure their kneecaps are nailed to the floor. Which is pretty much what Apple has been doing.

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Quentin Vole
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Quentin Vole

Speaking of Chinese knock-offs, I remember visiting Stanley Market in Hong Kong 30 years ago, when HK made most of the Paris couture garments. On the market you could find ‘genuine’ Dior gowns, they’d get an order for 300 (say) dresses and make 400. The only thing missing was the label, since they were only given enough labels for the actual order, but on the next stall was a guy selling copies of couture labels, which he’d happily sew into your newly purchased garment.

I’ll bet something similar goes on in Dhaka today.

Jonathan Harston
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Jonathan Harston

I lived there 25-28 years ago, and saw similar things myself.

BarksintheCountry
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BarksintheCountry

Your buddy could have refined and honed his skills at the US IRS which operates precisely on this model.